NYK Celebrates Its 128th Anniversary

NYK president Yasumi Kudo remarks to NYK employees at the October 2 ceremony are as follows:

Overview of the Economy Since the end of last year, the Japanese economy has been revived under the influence of Abenomics.*

The correction of the strong yen and recovery of stock prices have hadpositive effects on earnings and investments for many Japanese companies. The NYK Group is no exception, having benefited in no small measure from those changes.

However, if we look at the Japanese economy in a wider context, taking into account the declining and rapidly ageing population, the ongoing lack of demand, the large fiscal deficit and other issues, it is clear that creating robust strategies and implementing them swiftly is essential to sustain stable economic growth. Fortunately, Japan’s selection as the host country for the 2020 Olympics is an additional, positive factor. We can expect a great deal from the current administration’s leadership in the years ahead.

The U.S. economy is on a steady track to recovery due to the continuation of quantitative easing by the Federal Reserve Board and the benefits of the shale gas revolution. However, there is the delicate issue of what will happen if quantitative easing is reduced in the future. In addition to having a direct impact on the U.S. economy, a reduction in easing would trigger a withdrawal of money from emerging countries and a slowdown in their economies, and the ensuing reaction could affect the U.S. economy. There is, therefore, still a degree of uncertainty.

In Europe, in addition to the strong showing by the U.K. and Germany, there is an emerging sense that the economy is bottoming out in several southern European countries. Nevertheless, it will take some time yet before fully fledged consumer activity is restored in Europe as a whole. In the Middle East, in addition to the long-standing tensions between Iran and Israel, internal unrest is still ongoingin Egypt and there is a risk that economic activity will shrink throughout the region including North Africa. Furthermore, the unstable political situation in Syria needs to be watched closely because, depending on how the situation develops, there is a danger that it could destabilise the entire Middle East. Potentially, this could have a strong impact on the global economy and on the business of the NYK Group.

Meanwhile, turning our attention to Asia, we can say that the economies in the Asian countries have stayed robust compared to Japan, the U.S., and Europe. Although China is reaching a state of near saturation in its role as the world’s manufacturing base and is no longer achieving the double-digit growth it enjoyed previously, it continues to maintain a high level of growth in the range of 7–8 percent. India and the ASEAN countries are also performing well at 5–6 percent.

NYK president Yasumi Kudo

In summary, while the global economy still faces uncertain factors, there is a steady trend toward recovery. The situation can be described as a continuing process of trial and error in pursuit of lasting and stable growth.

*Abenomics: (a portmanteau of Abe and economics) refers to the economic policies advocated by Shinzo Abe, the current Prime Minister of Japan.

The Business Environment

Within this global economic situation, what is the business environment for our marine transportation and logistics business?

While demand for cargo varies from region to region, it has surpassed the levels achieved before the start of the global recession in September 2008, and it is steadily increasing. Nevertheless, we continue to struggle with market stagnation amid the significant gap between supply and demand that remains unresolved for the majority of vessel types. There are two reasons why this large gap still exists, even now that a full five years has elapsed since the global recession. The first is that, although cargo movements drastically decreased immediately after the global recession in 2009, they recovered at a pace beyond all expectation the following year. Since levels had promptly returned to pre-recession levels, everyone mistakenly assumed that business had recovered its former double-digit growth, and resumed orders for new vessels. Ultimately, it was not until 2011 that a brake was put on orders, once the slump in cargo movements became apparent.

The second reason for the supply and demand gap is that, as the price of fuel skyrocketed, ships with poor fuel efficiency became economically obsolescent. This was a key issue for containerships and the move to ultra-large vessels offering the best fuel efficiency became critical for maintaining cost competitiveness. This in turn was spurred on by the lower prices accepted by ship manufacturers for orders, and new orders continued to increase.

So, is this problem a temporary issue that will improve with the passage of time? I believe we must accept that, with the exception of car carriers and certain special vessel types, oversupply is the usual state of affairs for the majority of vessel types. There is a time lag of roughly two years from the time an order is placed to the completion of a newly built vessel. Therefore, if cargo movements suddenly worsen, the supply and demand gap expands sharply. Even if cargo movements do not actually decrease and the rate of growth for cargo movements merely slows, in many cases orders for newly built vessels are made on the basis of the previous cargo movement growth rate. So the supply and demand gap increases for at least two years.

Furthermore, it is a basic principle of the ship-owning business to order newly built vessels above all things when prices are low, and this type of order for new ships has tended to increase recently, including speculative orders. In other words, we must consider that the shipping business has a structural problem that makes it prone to oversupply.

The Path We Should Follow

As the economies of Asia and the emerging countries develop, cargo movements will steadily increase in the future. However, at the same time, The business environment will always be challenging due to the constant gap between supply and demand. How can we survive and continue to grow in that environment?

I believe the answer lies in four areas:

1. Expanding the areas of our businesses where the supply and demand gap does not exist or is irrelevant

2. Improving the structure of our business model to eliminate the supply and demand gap or to make it irrelevant

3. Exploiting our unique skills in coordination to thoroughly reduce the 3 M’s (muda, mura, and muri; i.e., non-value adding activities, unevenness in production or work activities, and excessive burdens)

4. Pushing our innovation to the utmost, with tireless intensity

(1) Expanding “More Than Shipping”

First, our businesses where the supply and demand gap does not exist or is irrelevant are growing steadily – as you are all aware. We are actively expanding the offshore business, including drill ships, shuttle tankers, floating production storage and offloading (FPSO) units, and floating storage and offloading (FSO) units. These require advanced safety standards and handling technologies that make these fields challenging to enter and largely involve long-term contracts. We are also expanding the LNG shipping business. Since these businesses are concerned with more than just ships, they fall within the scope of our “More Than Shipping” programme. In the car transport business, long-term contracts are almost non-existent. However, since the business uses a special type of vessel that carries absolutely no cargo other than cars, when cargo movements decline and recovery is not expected for some time, old surplus vessels are scrapped.

This results in a unique business environment where the supply and demand gap does not arise. However, the persistently strong yen had led to local production for local consumption. In other words, overseas local production is expanding but we cannot expect major expansion of seaborne cargo volumes in the future. As a way out of that, we are expanding the on-land side of the business through terminals for finished automobiles, inland transportation, PDI, and so on, which are also within the scope of More Than Shipping.

Meanwhile, our logistics business – Yusen Logistics Co., Ltd. – is basically not affected by the supply and demand gap for containerships or cargo aircraft. Instead, it has the advantage that space cost becomes lower as the gap becomes larger. That is the reason why we have put so much effort into developing this business.

(2) Pursuing the Best Cargo - Fleet Balance

The second way to make the supply and demand gap irrelevant is, simply put, a speedy return to a situation where committed cargo volume exceeds the size of the committed vessel fleet. In other words, not having more ships than we need for our committed cargo or that exceed our sales capacity. This is mainly a challenge for the dry bulk carrier division with its Capesize and Panamax carriers. The NYK Group has traditionally maintained a policy of having committed cargo that exceeds space in committed vessels.

That backfired during an unprecedented and long shortage of ships from 2003 to 2008. To fulfill cargo shipping contracts, it became necessary to charter vessels from the market to make up the shortage. In the end, we were not able to handle the volume with short-term chartered vessels, and were forced to make medium-term (approximately five-year) charter contracts with high charterage. Moreover, a later downturn in cargo movements plunged us into a situation where our committed vessel fleet exceeded our committed cargo extremely. If we paid the cancellation fee and reduced the fleet now, the cancelled ships could disrupt the market as charter-free vessels. Since we will be able to return the expensive chartered vessels in a few years, the crucial thing is to make full use of the surplus vessels until then, and to build up long- to medium-term contracts at reasonable freight rates.

At the same time, to alleviate the unfavourable balance between fleet size and committed cargo, even a little, we must further step up development of slow-steaming operations. Recently, the dry bulk market has recovered significantly, especially for Capesize bulkers, and improved the financial performance of the surplus charter-free vessels. However, we should not leave the current situation where our committed vessel fleet exceeds our committed cargo. We do not accept a business model that makes a profit enjoying the market having plenty of charter-free Capesize bulkers. We need to put our best efforts into eliminating the surplus tonnage (muda) so that our fleet capacity can be necessary and sufficient for us to perform our contracts with clients. I understand that containerships have maintained a steady ratio of short-term chartered vessels, and are OK in terms of cargo-fleet balance. In the future, we must not hold on to ships long term, beyond our sales capacity. As long as this is a business where long term cargo contracts do not exist, and where there are always seasonal fluctuations in cargo movements. We must first make it our top priority to make sure our long-term core fleet is highly utilised, and hold firm to the basic policy of handling cargo volume with short-term chartered vessels that our core fleet cannot cover – even if they are slightly more expensive. At the same time, achieving cost competitiveness in terms of fuel efficiency is a major issue for the core fleet of containerships – particularly for the long-haul

Asia-Europe routes.

Fortunately, we are not constrained by a cargo-fleet imbalance and have plenty of choices. We will consider our options carefully.

(3) Reducing the 3 M’s

The third way we can meet the challenges we face is to thoroughly reduce

the 3 M’s:

· Muda: non-value adding activities

· Mura: unevenness in production or work activities

· Muri: excessive burdens

The key here is being proficient at coordinating the capacities of the

parties involved. There is no doubt the transition to vessels with high fuel efficiency is progressing rapidly as fuel costs soar, but that doesn’t mean that they can all be replaced at once. Therefore, it is no exaggeration to say the competitiveness of each NYK company is substantially affected by how effectively slow-steaming operations are implemented. Cost-competitiveness is also significantly affected by factors including how much we minimise the muda movement of empty containers in the containership business, or ballast voyages in the case of bulkers.

This matter is a test of human ability rather than technological or mechanical capability and is thus a perfect opportunity for us. With regard to fuel saving activities, we are now using the knowledge gained from the IBIS project,* which was carried out for containerships, to develop IBIS-TWO.** This will enable us to apply acquired knowledge to intensive fuel-saving activities in other divisions. While systems technology is important to support this project, the most vital element is a shared, keen awareness that allow vessel operators, onshore operators, and on-site port officers to find room for the vessels to slow down even at the slightest degree, and the constant coordination among the three of them.

To minimise the muda movement of empty containers, we are currently putting our greatest effort into the EAGLE project.*** Even at apparently high freight rates, sending outbound cargo to a destination where there is no cargo for the return trip means the empty containers must be sent back to Asia. When those costs are considered, is this cargo really profitable? Again, even if there is cargo for the return voyage, if the destination is a place where there are surplus containers, extra effort is needed to forward the containers to another port where there is a shortage. This also has a significant impact on the yield ratio. Therefore, while fully utilising systems technology, it is vital for the parties involved to be constantly coordinating information.

As part of the effort to minimise ballast voyages, NYK-Hinode Line Ltd. and NYK Global Bulk Corporation (NGB) were merged yesterday, and a new company,NYK Bulk & Projects Carriers Ltd., was established. While the main business of NYK-Hinode was the transportation of steel and plant from Japan and Asia, the main business of NGB was the transportation of non-ferrous ores, auxiliary materials for steel manufacturing, wood, and grain to Japan and Asia. Therefore, the nature of the business of these two companies puts them in a position to complement each other’s ballast legs. Of course, the two companies have been cooperating up to this time, but being separate companies posed some challenges for in-depth harmonisation.

For example, when thinking about the design of new vessels to build, did NGB take into account the transportation of plant or steel? On the other hand, has NYK-Hinode paid attention to cargo for the return voyage, cargo such as nonferrous ores? Unfortunately, these points had not been fully considered, but with coordination the substantial muda of ballast voyages could have been further eliminated.

*IBIS (Innovative Bunker and Idle-time Saving) Project: a project to share current information about operations, weather, and port traffic so that timely decisions can be made to reduce idle time and fuel consumption **IBIS TWO: a project from fiscal 2013 to use the knowledge and know-how acquired by IBIS for other types of vessels – not only containerships. ***EAGLE (EQC Aspiration for Global Efficiency) Project: a project to optimize container operations through yield management

(4) Adding Value through Innovation and Ingenuity

Finally, we come to the exercise of innovation and ingenuity. It does not go too far to say that energy conservation and fuel saving are now a matter of life and death for shipping companies. However, it would be far too simple to respond to that only by up-sizing ships. Although significant results can be anticipated from the transition to larger vessels, we must remember this is based on the major assumption that the ships are operating at full capacity. Cargo movements are naturally subject to seasonal fluctuations and it is necessary to be flexible about how ships are allocated to routes. I am certainly not rejecting the use of large vessels altogether, but it is something that any business can do, whereas we need to be constantly seeking the added value that differentiates us from other companies. A good example is our vessel Soyo, which is equipped with an air-lubrication system and was selected as Ship of the Year 2012 by the Japan Society of Naval Architects and Ocean Engineers.

Conclusion

Last year, in fiscal 2012, we achieved our required target of getting out of the red, and now the greatest challenge for this fiscal year is to firmly establish a recurring profit. We were able to post recurring profit of ¥11.4 billion for the first quarter, and are forecasting ¥24 billion for the first half of the fiscal year, which gives us a sense that profitability is improving. I would like to express my sincere respect for the effort you have all made in this difficult business environment. Even so, this profit level is still not sufficient to meet the expectations of our stakeholders. Let us all do our best, working as a united group, to bring profits up to where they should be. We can do this by steadily putting the points I have raised into practice, one by one – with integrity, innovation, and intensity. I would also like to touch on the topic of compliance. Last year, NYK was inspected by the Japanese and U.S. authorities on suspicion of violations of antitrust laws in our car transport business. We also received written inquiries from the European authorities. Those investigations are still ongoing, and we continue to give them our full cooperation. As I have stated repeatedly in the past, the fact that we have been suspected by the authorities and subject to on-site inspections is something we must take extremely seriously. To ensure that the same thing never happens again at the NYK Group, we are steadily developing measures such as the establishment of an executive committee to oversee thorough antitrust law compliance and the introduction of a system to appraise legal risks in new business investments. I ask each and every employee to endeavour to comply with the antitrust laws with a strong sense of personal responsibility.